Bandwidth is a commodity. So is oil. This is not bad news (so stop worrying)… 

It’s strangely reminiscent of the ICT boom. There are big-ticket takeovers, corporate opulence bordering upon the obscene and profits raked in at levels that the less sophisticated branches of the media routinely measure in ‘millions of dollars per minute’. If this is capitalism, we’d all vote with our feet and head for the modern-day equivalent of the Finland Station.

At the moment it’s the oil industry that draws such ire, after seeing the basic price of its commodity almost double in little more than a year. At more than US$50 per barrel, instead of our happy  20-year benchmark of sub-US$28, it’s a trigger for global economic trauma. It’s shocking and, as it were, it’s crude…

How odd must it be for ICT professionals to hear about commodity prices going so high. After all, the ‘commoditisation of bandwidth’ was synonymous with the death throes of the telecom boom. In theory, so much capacity was being built and lit that prices were falling to sub-profitable levels. Bandwidth experienced a ‘glut’, which is a nasty word at the best of times.

Trading places?
Indeed, brokers were established to exploit this ‘glut’. What of these short-lived denizens of the new era of tradable bandwidth? They are mutating into systems integrators or interconnection lawyers.

For example at the end of September, 2004, Band-X, the soi-disant original bandwidth exchange launched amid self-trumpeting fanfare in 1997, sold its IP transit trading exchange business to Arbinet-thexchange. “We are focusing our resources on providing high quality managed switching, interconnection and call termination to the telecoms industry" said Stephen Beynon, Band-X CEO, last September. "We are delivering services to meet customer demand generated by what is a seismic shift into VoIP across the industry. Band-X provides a bridge from the older technologies to the newer ones, reducing risk and increasing capability for telecoms operators, service providers and ISPs.”

Arbinet, founded in 1996, is a NASDAQ-listed clearing house and trading floor for bandwidth among major carriers. It became Arbinet-thexchange Inc in 2002 and today claims to count “8 of the top 10 largest carriers” among its customers.

I, co-bot
To understand the concept of commoditisation and the nature of such trading, a cursory glance at the economics of how different commodities work is required. The sharper among you will realise that it may have something to do with supply and demand.

Any casual visitor to Cochin in India will inevitably find the trading floor for chilli peppers. Casual visitors are not normally allowed in, but that’s less for reasons of commercial confidentially than due to the risk of chilli dust in the eyes when a deal is flamboyantly sealed. That aside, it’s just like trading pork bellies in Chicago.

Another relevant instance of commoditisation is rice in China. It’s ‘per bit’ cost is both infinitessimal and liable to state price control. But the volume, of what is a staple commodity, is at the same time incredible. If you had a monopoly on the rice market, you would not complain.

The market for oil is more fluid — as is its price. Its producers have the ability to constrain supply in the face of rising demand (hence US$50 per barrel). For many this is a no more than a cartel, which is not inappropriate since ‘cartels’ were almost trademarked by OPEC, the oil producers’ club, in the 1970s.

Vegan
The situation surrounding telecom bandwidth commoditisation is a mix of chilli, rice and oil. In the right proportions, it amounts to a vegan recipe for a Redux dish.

This would make a finer recipe than that of the boom. The crash of technology stocks in 2000 coincided with the peak of alleged bandwidth oversupply. The word ‘alleged’ is used here because, in the history of telecom, supply had never outstripped demand to the point that prices for the latter became unconstrained by the former. That this appeared to happen in the lead-up to 2000 was due to unsustainable business models and false accounting, with venture capitalists (and others who should have known better) throwing money at each new proposed strand of fibre.

Seen in this way, the ‘boom’ was no more than a form of ‘Chapter 11’ for solvent companies. This not only precipitated the ‘bust’, but exacerbated it as genuine Chapter 11 considerations for the insolvent kicked in. Think WorldCom…

In both boom and bust, basic telecom supply and demand was skewed in favour of the disjointed principles of ‘possibility of supply’ and ‘probability of demand’. Should one of these not go to plan, the industry investor’s gamble fails. Should both go wrong, it’s meltdown. Hey, ho: we got meltdown.

Nice dish, quite spicy, not cheap
This is so different from the factors facing the ingredients in our commodity recipe. If the bandwidth providers can learn a bit of this, they might turn the corner.

From rice, it is obvious that although unit costs can become too small to count, volumes continue their inevitable rise. A glance at Malthus will also tell you that cyclicality of supply guarantees that the journey from surfeit to shortage is quick and inevitable. The ICT operators are currently enmeshed in a winter of ‘failed crops’ and the over-supply of bandwidth is shrinking. At some point, despite all the increases in bandwidth productivity, the overall supply will start to diminish. And prices will rise.

From chilli, we learn that added spice is optional and only attractive when it is affordable. In ICT terms, chilli is the mainstay of the ‘sweat the assets’ ideal but by  its very nature its value remains low. If it becomes expensive, as it did briefly a year or so ago, it prices itself out of the market. Demand wanes and the price falls back. Prices should remain sustainable but on the low side.

From oil, we get an entirely different form of commodity price fluctuation. This involves constraining supply in the knowledge that demand is growing and cannot be trimmed back. Add the fact that, on the supply-side, carrier consolidation may be assisting in the creation of a cartel. And prices will rise!

Covered and simmered
In an era where demand will not reduce, the ICT industry holds two key pricing levers in terms of supply. The funny thing is that it has concentrated on the weakest initiative in its current, beleaguered state.

Back to the cookbook. Turn up the heat…
Jim Chalmers